Zhongsheng breaks new ground on Asian CB

Chinese car dealer takes advantage of a soaring share price and rising rate environment to price a one-year convertible bond, the shortest tenor ever seen in Asia.
Zhongsheng is one of the biggest dealers of Mercedes-Benz cars in China.
Zhongsheng is one of the biggest dealers of Mercedes-Benz cars in China.

Chinese auto dealer Zhongsheng Group broke new grounds in Asia’s equity-linked market on Wednesday by pricing a one-year convertible bond, the shortest tenor ever for an equity-linked product in the region.

The Dalian-based car dealer, which sells luxury brands including Mercedes-Benz and Toyota Lexus in China, raised HK$2.35 billion ($301 million) through the sale of a zero-coupon convertible bond that matures on October 25 next year.

Asian issuers are used to issuing five-year convertible and exchangeable bonds with a three-year put option for bondholders and a three-year soft call provision. Under this structure, bondholders have exposure to at least three years of stock volatility, a reasonable timeframe for them to capture the upside of the stock and potentially convert their bonds into shares.

Some prominent equity-linked issuers, such as Hong Kong-listed China Overseas Land & Investment (COLI) and Singaporean property giant CapitaLand, have managed to extend the maturity by issuing seven-year deals with four-year put options. There were also smaller issuers that opted for shorter-dated bonds, such as the two-year/one-put CB issued by Hsin Chong in late 2015.

But there has never been a one-year deal. Traders said one-year CBs could hardly gain any traction by conventional standards because the stock is highly unlikely to reach the strike price within such a short period of time.

Favourable share price

Zhongsheng was able to price a deal with this tough structure thanks to the strong run of its share price since the beginning of the year. Year-to-date, the stock has jumped 151% and ended just 5.5% below its all-time high of HK$18.7 at Wednesday's close of trading.

The price surge came on the back of a 121% year-on-year leap in net profit to Rmb1.35 billion ($206 million) in the first half of the year, partly attributable to stronger new car sales as well as expansion into new brands such as BMW, Jaguar Land Rover and Porsche.

As a result, Zhongsheng’s realized 30-day volatility has spiked to 42.7% over the last six months compared to 22.1% from 2013 to 2016, suggesting the option value is much higher than before.

“The company’s price surge makes it a good time to do financing now, particularly when considering the fact that it underperformed the market last year and any equity financing was not favourable then,” a source familiar with the situation told FinanceAsia.

For bondholders, the one-year deal serves as a good investment to those who are upbeat about the sector’s prospects, while allowing a certain degree of flexibility to reinvest the money to other higher-yielding products a year later after a widely-tipped US rate hike.

As such, Zhongsheng’s latest deal is a good example of how issuers and advisors can adjust deal structures to meet funding needs while attracting investors in a rapidly-changing environment.

Deal terms

The zero-coupon CB was initially marketed with a conversion premium of 15% to 20% over Zhongsheng’s price of HK$17.64 at Wednesday close. Final pricing was fixed at the lowest point of the range at 15% and translated to a HK$20.3 strike price.

On the back of strong demand, Zhongsheng was able to fully exercise the $75 million upsize option on top of the $225 million base offering.

Zhongsheng is a first-time bond issuer so there was no credit benchmark. Investors were generally assuming credit spread of 225 basis points over Treasuries and a 5% stock slippage, translating to a bond floor of around 97% and an implied volatility of about 25%.

However, sources said these credit assumptions were largely indicative because of the extremely short tenor and the zero-coupon nature which make the bond almost like a pure equity instrument.

It is worth noting that the only convertible bond ever issued in China's car dealership sector – China Yongda Auto's Rmb1 billion CB issued in 2014 – was a huge success after bondholders converted nearly all the bonds into shares earlier this year.

JP Morgan was the sole bookrunner of the bond issue.

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